Annual Economic ReportIntroductionThis document reviews the broader economic context within which the South African Reserve Bank (the Bank) conducted its operations in 2010/11, focusing on international and domestic economic developments. The emphasis is on the year 2010 and the first half of 2011. On the occasion of the Bank’s 90th Anniversary, the Annual Economic Report also includes a number of brief analyses covering the period from 1921 to the present, in the form of boxes.Over the past 18 months the global economy continued on its course of recovery. The strongest growth momentum was provided by the emerging-market and developing economies, led by Asia, while the advanced economies registered a more subdued performance. The major advanced economies, having been impacted most by the financial crisis, continued to support activity levels with accommodative monetary policies. At the same time, policy-makers in these countries had to engage in fiscal consolidation, as the quantum and cost of public debt had escalated to levels that raised concern about sustainability in the public finances. In peripheral Europe the economic crisis transmuted into a sovereign debt crisis which remained unresolved despite large support packages from the European Union (EU), European Central Bank (ECB) and International Monetary Fund (IMF), and the adoption of austerity measures by the countries involved.Further impediments to a smooth global recovery included the high levels of international commodity prices, fuelled by strong demand growth in the emerging-market economies. In the case of oil in particular, fears about the security of supply following the political turmoil and conflict in a number of countries in the Middle East and North Africa (MENA) region buoyed prices further. The earthquake and tsunami that hit Japan on 11 March 2011 disrupted global supply chains, further weighing down activity. Nevertheless, the recovery in the advanced economies appears to be broadly on track, although significant risks remain.The strong demand for and prices of commodities favoured many countries in sub-Saharan Africa, and growth prospects for the continent have brightened, along with greater emphasis on the improvement of infrastructure and sound economic policies.In South Africa the business cycle reached a lower turning point in August 2009. The recovery that followed was well synchronised with the global economic cycle. In the subsequent six quarters activity strengthened in all the main sectors of the economy, albeit from a low base. A contraction of 1,7 per cent in real gross domestic product in 2009 made way for an expansion of 2,8 per cent in 2010, with annualised growth rates of more than 4 per cent in the final quarter of 2010 and first quarter of 2011. Of particular significance is that employment also started increasing from the second quarter of 2010.From an aggregate demand perspective, the major driving force behind the recovery has been final consumption expenditure by households. Real spending by households came from a low base, having contracted up to the middle of 2009, but has since risen at annualised rates of around 5 per cent. The recovery in households’ expenditure was especially strong in the area of durable goods such as motor vehicles. While lower interest rates have given indebted consumers a reprieve, rising real disposable income has been driving the expenditure, as opposed to a rapid increase in debt levels. Household debt has been rising moderately but disposable income has been increasing more forcefully, resulting in a declining household debt ratio. While the debt ratio remains high, its downward trend suggests more sustainable behaviour so far in the current phase of economic expansion.Real final consumption expenditure by government has also risen steadily, except for purchases of military equipment, which is understandably quite volatile.Real fixed capital formation tends to lag the economic cycle, and continued contracting throughout 2009 and early 2010. However, it subsequently resumed an upward trend. Th